10 Tips for Simplifying a Complex Process
This article first appeared on medium.com.
The average rate on a 30-year fixed-rate mortgage in the U.S. is the lowest it has been in fifty years.
I have been a homeowner for just over 6 years. In that time, interest rates have fluctuated substantially.
We recently finalized our third mortgage refinance overall, and the second refinance on our current residence. While navigating this process once again, I knew that I had to write these tips down and share everything I know and that I’ve learned about refinances.
So, this is for you… Read this before you refinance your mortgage.
Tip #1 — You Can Refinance Without Paying Money Out of Pocket
I moved into my current home in June 2018 (4.875% interest rate), I refinanced in July 2019 (3.625% interest rate), and I closed on this current refinance in August 2020 (2.625% interest rate).
Obviously, I am thrilled at this good fortune. My actual monthly payment on this new loan will be $590 less than what I was paying when I first moved into the home, and $218 less than what I’ve been paying each month for the past year!
That being said, I have had to pay for these refinances. There are a number of fees involved with the creation of a new loan; and these costs are known as closing costs.
However, I did not pay for any of these closing costs with actual money out of my pocket. Rather, I “rolled” these costs into each new loan. Let me show you visually how this was done using some sample numbers:
- June 2018: new loan amount = $200,000
- July 2019: remaining loan amount = $196,982 (i.e., $3,018 of principal was paid down over the first year)
- July 2019: new loan amount = $206,982 (i.e., “rolled” $10,000 of closing costs from the refinance into the mortgage)
- August 2020: remaining loan amount = $203,094 (i.e., $3,888 of principal was paid down over the first year)
- August 2020: new loan amount = $213,094 (i.e., “rolled” $10,000 of closing costs from the refinance into the mortgage)
Now, it’s important to note in this example that 26 months after moving into the home, I owe more on the house than when I moved in.
It’s also important to note that my 30-year term has started over each time I’ve refinanced. In other words, I am still 30 years away from paying off the loan, even though I’ve already been in my home for 2 years.
So was it worth it?
You bet it was. Let me prove it to you.
Tip #2 —If the Numbers Make Sense, Then Refinancing is Worth the Hassle
I use mortgagecalculator.org and a house payment schedule spreadsheet that a former co-worker and I built to decide whether or not a refinance is worth it. For example, in analyzing the information I provided previously, here is the total interest that I would pay on each loan over 30 years:
- 4.875%: $181,028.32 interest over 30 years on a $200,000 loan
- 3.625%: $132,839.00 interest over 30 years on a $206,982 loan
- 2.625%: $95,028.14 interest over 30 years on a $213,094 loan
Granted, you paid interest for a year at each of the first two rates, so you’re not realizing your full savings. But based on my calculations, even after rolling $20,000 of closing costs into the loan amount, your interest savings on the first refinance would be $38,506.18 and your interest savings on the second refinance would be $30,986.44.
It’s your call… is it worth it to pay, or rather “roll,” $20,000 into your mortgage to save $69,492.62 in interest?
Is it worth it to decrease your monthly payment from $1,058.42 to $943.94 to $855.89?
To me, it was worth it.
Tip #3 — The Break-even Point
A loan officer once told me that “the ideal break-even point on a refinance is 3 years or less.”
To calculate a break-even point, take the total closing costs divided by the monthly savings:
- 3.625%: $10,000 of closing costs divided by $114.48 (i.e., your monthly payment decreased from $1,058.42 to $943.94) equals 87 months, or 7.28 years
- 2.625%: $10,000 of closing costs divided by $88.05 (i.e., your monthly payment decreased from $943.94 to $855.89) equals 114 months, or 9.46 years
It’s not enough to just analyze the interest savings… The break-even analysis allows you to calculate how much time it will take to “pay off” the closing costs you incur.
We were only in our first home for four years. We knew it was a starter home, and our intent was not to stay in that home long-term. So in the scenarios above, it wouldn’t make sense to incur closing costs that would take over 7 years to essentially pay off.
Circumstances change. We do intend to stay long-term in our current home. Fortunately, unlike the examples above, my actual break-even point on this current refinance is 3.7 years ($9,705 of closing costs divided by $218 of monthly savings).
Tip #4 — Get Multiple Quotes
It is essential for you to get multiple quotes on your refinance.
The first company we approached offered a 3% rate for $11,300 in closing costs. The second company we contacted, however, offered a 2.625% rate for approximately $10,000 of closing costs.
Ultimately, these two companies wanted our business, dropped costs (and the first company matched the 2.625% rate), and eventually offered virtually the same deal.
Imagine what taking the first deal we were offered would have cost us… Thousands of dollars of interest over the life of the loan, and a couple of thousand dollars extra in closing costs.
In my opinion, it never hurts to get a second opinion. Once we had two companies competing for our business, we knew we were going to get a great deal.
Tip #5 — “Hard” Closing Costs and “Soft” Closing Costs
Some of your closing costs will vary (fees, points, etc.), while others will be the same (escrow items and interest), regardless of which lender you choose.
This was explained to me as the difference between “hard” closing costs and “soft” closing costs. “Hard” closing costs are non-negotiable — these are your escrow and interest amounts. I will explain more about these accounts later in this article. Regardless of which lender you select, the “hard” closing costs will be the same amount.
“Soft” closing costs are negotiable — these are lender processing and title fees, recording fees, appraisal fees, and mortgage points. Once we had two competing offers, both lenders began reducing “soft” closing costs to try and win our business.
Tip #6 — Know Your Goal… The Lowest Rate Isn’t Necessarily the Best Option
What is your goal for refinancing your mortgage?
As I mentioned previously, we intend to stay in our current home long-term. Thus, we were willing to pay mortgage points (see the link in the section above) to reduce our interest rate.
However, remember the break-even point… If you are only going to be in your current home for a short period of time, you need to do the math. It makes no sense to pay potentially a couple of thousand dollars for mortgage points to secure the lowest interest rate available if you’re just going to move in a year or two.
Another goal for you might be to get access to cash or to get out of mortgage insurance. I will discuss these options later in the article.
Tip #7 — Consider Refinancing To Get Out of Mortgage Insurance
When we purchased our townhome in 2014, we were only able to put 10% down at closing. “Typically, borrowers making a down payment of less than 20 percent of the purchase price of the home will need to pay for mortgage insurance.”
Mortgage insurance is good for lenders, but it is not good for me as the buyer as it raises the costs of the loan.
There are various ways to get rid of mortgage insurance. We did it by refinancing the mortgage on our townhome. This won’t necessarily work for everyone, but we had three good reasons that made this successful:
- We finished the basement in our townhome in early 2015
- Property values had appreciated in our neighborhood
- Interest rates had dropped below the rate we had at the time
As part of the refinance, we had an appraisal on the home, and the appraisal amount was high enough that our loan amount was just less than 80% of the property value, qualifying us to escape mortgage insurance.
If you are in a similar situation, now is a great time to see if you can get out of mortgage insurance too.
Tip #8 — When You Choose a Lender, Make Sure You Both Understand the Details of the Desired Loan
This is a convenience tip.
As mentioned previously, we had received multiple quotes. We had let both lenders know our intent to roll all closing costs into the new loan.
Once we had selected a lender, the first documents we were sent to sign showed that we would have to come to the close with cash.
This required a bit more back and forth — reminding the lender that we weren’t willing to pay anything out of pocket, and the lender then sending revised documents to sign.
Overall, it was no big deal, it’s more just a matter of convenience. Our refinance process was smooth and fast, but more clarity upfront would have further streamlined the process.
Tip #9—Cash Windfall
I have written before that only 40% of Americans would cover a $1,000 emergency with savings.
Refinancing can be a fantastic way to generate cash if you do it correctly…
First, as mentioned above, you don’t have to pay anything out of pocket for your refinance. Simply roll the closing costs into the new loan amount.
Second, discuss with your lender how you can skip two mortgage payments. We finalized our refinance on Thursday, August 6, 2020. This allowed us to skip our August 2020 mortgage payment with our previous lender, and our September 2020 mortgage payment with our new lender.
As illustrated above, if your monthly mortgage payment was $943.94, then skipping two payments is like putting $1,887.88 in your pocket.
Third, depending on the specific details of your closing disclosure, it is possible to end up receiving cash back at closing. You can work with your lender to make this happen.
For example, I illustrated above that the new August 2020 loan amount would be $213,094. It is possible to structure the details of the loan with the lender to, say, set the new loan amount to be $213,500, or something like that. That way $406 cash would go to you at closing.
For us, we received just over $300 cash at closing for our refinance.
Fourth, I defined “hard” closing costs above. If your new loan will have an escrow account (i.e., you will pay 1/12 of your property tax and homeowner’s insurance each month as part of your mortgage payment), then a portion of these amounts will be included in your closing costs.
As you are essentially catching your escrow balance up, the escrow balance you had built up with your previous lender will actually be refunded to you. In my experience, I have typically received this escrow refund within a couple of weeks of my refinance closing date.
I won’t tell you what to do with this cash windfall… but if you have credit card debt or no emergency savings fund, please consider putting your money there before just paying extra toward your mortgage!
Tip #10—Deciding on the Term
There is one last decision you need to make — the term.
The 30-year mortgage is probably the most common, while the 15-year and 20-year are also options. Refinancing ultimately opens the door for what you want to do.
Use mortgagecalculator.org to calculate what your monthly payments would be under each of these options.
I have written before that everyone has an opinion when it comes to money… Dave Ramsey, for example, is a proponent of the 15-year mortgage. David Bach, on the other hand, recommends the 30-year mortgage, but getting on a bi-weekly mortgage payment plan whereby you can pay off a 30-year mortgage in approximately 22 years.
Ramsey and Bach are both bestselling authors and widely respected in the financial community — so who’s right?
Ultimately, do what makes the most sense to you. I elected the route of the 30-year mortgage, but I am looking into the bi-weekly mortgage payment option and will report back in the future.
Conclusion
Whether you think you qualify to refinance or not, you’ll never know unless you ask.
While refinancing on August 6, 2020, the woman at the title company said: “you should never have to refinance again. I can’t imagine rates ever dropping below where they’re at right now.”
That’s music to my ears… and it should be music to your ears too.
Disclaimer
As this post is finance-related, I’d better include a disclaimer… This post was simply an attempt to share some ideas to simplify a seemingly complex process.
I have shared my opinions, and now it’s your turn to do your due diligence to research this topic in more detail for yourself.
You are responsible for your choices and any action you take.